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BW Businessworld

The Craze For Auctions

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The Comptroller and Auditor General (CAG) is in the news again, this time on the grant of licences for coal mining. He has made estimates of the loss to the government from its failure to auction coal licences. It happened that the licences were issued when the Prime Minister had not appointed a minister of coal and was, therefore, himself in charge of the ministry. It follows, although the CAG did not put it that way, that the PM caused a loss of lakhs of crores to the government. The PM earned a doctoral degree in economics from Oxford University. So he should not only have known how he was causing loss, but he should have known how the loss could be prevented.

According to the CAG, the zero-loss method was auction of coal blocks. This is not new; the CAG earlier estimated loss to the government arising from other allocations, the latest being telecommunication licences. The CAG’s methodology was swallowed hook, line and sinker by the Supreme Court, which expropriated the holders of 2G licences given by A. Raja as well as their 80 million customers who had regularly paid their bills, and ordered the government to auction the spectrum it had given away. More recently, the opposition has held its trademark riot in Parliament on the same grounds.
 
I am a strong supporter of the CAG as an institution. In our contentious, futile, theatrical democracy, he is one of the few who goes on conscientiously doing his duty. Paranoia is our national disease; it is, therefore, really remarkable that no one accuses the CAG of being corrupt or crooked. Congressmen are mightily annoyed with him, but they still do not question his credentials.
 
I believe that auctions are a better way of allocating scarce resources than ministerial or bureaucratic discretion. Discretion does not automatically imply impropriety or corruption; but auctions will normally be more profitable for the government than allocation by humans. However, both the Supreme Court and the CAG, let alone members of Parliament, are naïve about auctions. The CAG’s naïveté is shown by his calculations; he takes the prices realised in actual auctions, and assumes that those prices would have been realised in auctions held on a much larger scale. In large-scale auctions, the supply of blocks or megahertz would be larger; it is simply wrong to assume that the larger supply would have been sold at the same price as a much smaller supply. All the economics one needs to know to avoid this mistake is elementary price theory taught at the very beginning of any course. I, therefore, conclude that neither the Supreme Court nor CAG displays knowledge of elementary economics. It is not possible to make a credible estimate of the loss caused by failure to auction.
 
Assuming it is decided to auction resources, one still has to decide when to auction, and whom to invite to bid. The price one would get in an auction depends on the returns the bidders expect to get over the life of a block or spectrum licence; their expectations depend on the state of the market for the product — coal or telephone calls, for example — which depends in part on the state of the economy. There is no way, in economics or any rational science, of predicting when people would feel optimistic and make high bids. Even if there were, it is highly likely that their optimism would prove wrong and they would go bankrupt. And what they bid also depends on how much money they can raise. The wider one throws the auction open, the better the bids one gets. This is an argument for letting in everyone in the world, and not restricting bids to Indians and their partners. That is something no judge or comptroller says.
 
A number of countries have auctioned spectrum; by studying their experience one might draw up some rules about how to do it. But if I were making policy, I would not auction all scarce resources — certainly not coal or oil blocks. I would ask bidders to bid for the maximum share of revenue or of profits they would be prepared to give the government. An auction for a fixed sum to be paid to the government upfront increases the risk to the bidder; an auction for a flow of profits or revenue divides the risk between the government and the bidder. It is not the ideal method; it would also make the government share in the consequences if the bidder turns out to be incompetent. If the government wants to insure itself against that, it can become the bidder’s joint venture partner and thus get a voice in management. But that would require assuming that the government is a competent manager — an unrealistic assumption in the present circumstances.

The author is Consultant Editor of Businessworld.

ashok(dot)desai(at)gmail(dot)com

(This story was published in Businessworld Issue Dated 03-09-2012)